Savills

Research article

UK Cross Sector Outlook 2022: Courage beyond compliance

Article

Contacts & Related Research

How will ambitious environmental targets and tougher compliance standards influence investment over the next five years? Emily Norton sets out three steps to consider while embracing the change

The pandemic has fundamentally changed the way we think about many aspects of property. But environmental, social and governance (ESG) issues were rising up the agenda well before Covid-19, lockdown and social distancing entered our lexicon. One of the key questions for investors is what this means for the long-term financial sustainability of different types of property – something that could be brought sharply into focus if, as and when interest rates rise.

THE REAL GREEN MACHINE

Our research launched at COP26 demonstrated the scale of investment needed to decarbonise property. This includes an estimated £330 billion to implement recommendations within residential EPC certificates. But it’s not just net zero that’s the issue here.

For all property sectors, tougher environmental compliance standards will now be the norm. The arrival of the long-awaited Environment Act sets ambitious air, water and biodiversity targets in England. For development, it brings a formal requirement for environmental offset within a couple of years. In Scotland, an ambitious new offsetting framework aims to align planning policy with net zero and biodiversity targets.

The further possibility of financial penalties (or taxes) for net polluters may well ensure compliance from hard-to-reach private households and businesses. For those affected, the cost of meeting compliance standards will often outweigh the returns, but the risk of holding stranded assets will become a bigger concern in many cases. 

However, it’s not just the operational yield that’s under challenge because of costs of compliance. Disclosure concepts like those proposed by the Task Force on Climate-Related Financial Disclosure and the Glasgow Financial Alliance for Net Zero suggest that, sooner or later, finance is going to come with more ESG strings attached.

DELIVERING THE SOCIAL FACTOR

Critics point out that such disclosure often leads to divestment from high-impact sectors, and property undoubtedly has a problem, contributing nearly 40% of UK emissions. And yet, property will always deliver the S (social) from a triple bottom line perspective; whether it’s jobs, homes or wellbeing. So clear, widely adopted metrics to prove this are essential to ensure that all property sectors remain investible long term.

Reflecting on this, the theme of this cross sector outlook for 2022 is ‘courage beyond compliance’. Bemoaning that it is getting tougher than it used to be is not going to cut it in the net zero economy. As a sector, we need to embrace the rising environmental baseline and get on designing places that offer great and enriching lives and that see well beyond the short-term clamour. Multiple small wins will get us some of the way there; patience, perspective and making sensible long-term investments that go back to basics will do the rest.

As a sector, we need to embrace the rising environmental baseline and get on designing places that offer great and enriching lives and that see well beyond the short-term clamour

THREE STRATEGIC STEPS

Getting back to basics will have three dimensions. First is understanding where we are in the cycle, particularly in the face of anticipated interest rate rises that will curtail prospects for capital appreciation in the absence of either rental growth (think logistics) or fundamental changes in demand for external reasons (think peat bogs).

Second will be recognising the impact of structural change, whether it be the reform of agricultural policy, the repositioning of retail or what we want from our homes post-pandemic. 

Third is avoiding over-reaction and staying alive to the possibility that some assets will become mispriced when markets are in a state of flux. As Mat Oakley points out in the commercial article, a rise in agile working does not mean a one-for-one reduction in demand for office space – lumping all retail together risks failing to sort the wheat from the chaff from an investment perspective.

This becomes increasingly important as across all our property sectors we see increasing harmonisation of total returns. In turn, this will make stock selection less siloed. We expect further outflows from traditional commercial property into residential, rural and infrastructure. However, location, connectivity and new metrics in social and environmental impact will provide confidence to investment, rather than the sector alone.

To reflect this convergence and the growing demand for asset innovation, we have our top ‘alternative assets’ that tap into the trends for more holistic returns that are rapidly becoming the holy grail.

Other articles within this publication

5 other article(s) in this publication